Macro-Finance Outlook January 2014
It's that time of the year -- I can't let the pundits pontificate without throwing my opinion into the ring. This post will take you on a tour of the individual components of The Conference Board's leading and coincident indicators as described in Chapter 2 of my new book Applied Equity Analysis and Portfolio Management. The chapter describes how to analyze the level and trend of each indicator, synthesize your analyses into discrete scores of -1, 0, or +1, enter these values into the chapter spreadsheet (included with the book), and let the spreadsheet average your scores into a diffusion index for each set of Conference Board indicators. We'll start with the leading indicators, which are depicted in the table below, along with the weights assigned by The Conference Board.
We'll start with the Leading Indicators. The most heavily-weighted component is the Average Length of the Manufacturing Workweek (weight = 0.2781), shown below with total employment in the manufacturing sector. The length of the workweek has regained its pre-recession level, which is typically interpreted as a positive signal. Unfortunately, as also shown in the graph, this longer workweek is being enjoyed by 5 million fewer employees in the U.S. since the start of the 2008 recession. Although the length of the workweek is up, the dramatic contraction in manufacturing employment leads me to score this indicator zero, rather than a more optimistic +1.
The second leading indicator is the ISM's New Manufacturing Orders Index (weight = 0.1651). The index has recently reversed its post-recession downtrend, bouncing strongly off its recent low of 50 (suggesting contraction). Notice how previous recessions have been preceded by similar downtrends. I will rate this indicator +1.
The University of Michigan's Consumer Sentiment Index (weight = 0.1551) has also been in a slow, steady uptrend, which merits a score of +1. Notice how the indicator collapsed in late summer of 2011 before Bernanke went to Jackson Hole and vowed to leave the QE spigot on full blast for "as long as it takes."
Interest Rate Spread Between the 10-year T-Note and the Fed Funds Rate (weight = 0.1069). This indicator is really a proxy for the slope of the yield curve. A steeply sloped yield curve indicates economic expansion, while a flat or inverted yield curve indicates slowdown or contraction. The curve has recently steepened, as longer-term rates have rebounded with the expectation of further tapering of the Fed's QE program. This indicator also merits a score of +1.
Manufacturers' New Orders for Consumer Goods (weight = 0.0811). Nominal and real Durable Goods Orders (deflated by the Personal Consumption Expenditure Index, or PCE) are shown below. The indicator rebounds sharply following the last recession, with Durable Goods Orders displaying slow, steady growth back to their levels preceding each of the last 2 recessions. The positive signal conveyed by this indicator merits a score of +1.
The Conference Board's proprietary Leading Credit Index is replaced by The Chicago Fed's National Financial Conditions Index (weight = 0.0794). Lower levels indicate "looser" borrowing conditions. Access to credit remains easy, especially for this stage of an economic expansion, so I'll rate this indicator +1.
Level of the S&P 500 (weight = 0.0381). The S&P 500 is on the verge of breaking out of its secular bear phase. As stock prices are supposed to lead economic conditions by 3-9 months, I will rate this indicator a cautious +1.
The reason for my caution over the level of US (and global) stocks is conveyed by the graphic below, which shows that Central Bank "activity" has fueled stock prices to a considerable degree. I remain concerned over what happens when more significant tapering occurs.
Manufacturers' New Orders for Capital Goods (weight = 0.0356). Unlike the pattern observed in Durable Goods, the Capital Goods Orders index has yet to match its level from prior expansions. The trend is up, however, so I'll rate this indicator zero.
Initial Unemployment Claims (weight = 0.0334). Unemployment claims continue trending lower. This indicator therefore rates a score of +1.
Building Permits for New Private Housing Units (weight = 0.0272). This indicator continues advancing, but only to levels associated with the depths of the 1982 and 1991 recessions. I will therefore rate the indicator zero.
The individual scores for each leading indicator and their weighted and unweighted averages (with possible lows and highs of -100% and +100%, respectively), are shown in the table below. The weighted diffusion index value of +70% is by far the strongest score since the most recent economic expansion began, indicating further acceleration of economic growth through the first half of 2014, and possibly longer.
The prospect of faster future growth was confirmed by a Q3 GDP growth rate of +4.0% (see below). The above analysis of the leading indicators corroborates that this may not be an outlier, but representative of our first year of growth exceeding +3.0% in almost a decade.
Next we'll consider the Conference Board's 4 Coincident Economic Indicators. This set of indicators measures the strength of current economic activity. Retail and Food Service Sales (substituting for The Conference Board's Manufacturing and Trade Sales indicator (weight = 0.5318, shown below)), have risen steadily since the last recession, earning this indicator a score of +1.
Total Nonfarm Payrolls (weight = 0.2597). The US economy is producing jobs, with total employment finally achieving its level from the mid-2000s.
Taking a shorter-term look at payrolls and hiring confirms that the pace of new job creation remains sluggish. I will therefore rate the Total Nonfarm Payrolls indicator zero -- the uptrend is positive, but the level of employment is not sufficient for a +1 score.
Personal Income Less Transfer Payments (weight = 0.1357). Personal income in the US is at an all-time high, which is definitely a positive. Examining the next graph below, however . . .
. . . I also compare Personal Income to Transfer Payments and Personal Consumption Expenditures. Notice how the upward trend in income and spending is strongly supported by an above-trend sruge in Transfer Payments (Social Security, Medicare, Welfare, etc.). Although I have strong concerns about future reductions in Transfer Payments and the effect on spending, I'll rate this indicator a cautious +1.
Industrial Production (weight = 0.0728). Until last year, Industrial Production was the most heavily-weighted coincident indicator. The nominal series looks encouraging, but the inflation-adjusted series displays some convoluted behavior. Although the trend in the nominal series is upward, the lackluster behavior of the real series leads to a ranking of zero.
Merging the above -1, 0, or +1 ratings into a diffusion index provides a score of +50% if all indicators are equally-weighted, and +67% if we use the Conference Board weights. The implication is that growth and economic activity have accelerated in the current period.
A few more charts to wrap up. Unless "this time it's different," historically bullish sentiment is usually a negative sign for equities -- the latest reading of bulls over bears makes me a little nervous:
We also live in a society that abhors discussion of long-term structural problems, like the tens of trillions in underfunded Social Security and Medicare liabilities -- we'll never be able to pay half the "promises" baby boomers are counting on:
It might not be the disparity between rich vs. poor that incites the revolution:
Perhaps it will be the one-time wealth tax that keeps being discussed -- the exhibit below is from a recent IMF report. Just because it worked in Cyprus, I wouldn't count on it working in the US . . .
Of course, much of our short-term prosperity is fueled by the US sinking deeper into debt every day:
Corporate profits as a percent of GDP are at an all-time high, while wages and salaries as a percent of GDP are at an all-time low:
And much of those profits are increasingly concentrated in the financial sector -- even with significant household deleveraging (ah, the power of those hidden fees . . . ).
Overall, there has been a significant pickup in economic activity in the second half of 2013. If the Fed treads lightly with its QE tapering, a real GDP growth rate of +3.0% in 2014 is definitely possible. Longer term, however, income disparity, federal deficits and debt loads, hopelessly underfunded entitlement programs and an increasingly "financialized" US economy present significant concerns -- concerns that US and global stocks seem content to ignore -- until they can't. For the short term, however, US stocks are likely to rally at the slightest provocation, and the outlook for growth and job creation in 2014 looks more promising than it has in any calendar year since the financial crisis.
Macro-Finance Outlook February 2013
Back in December I weighed in with my economic call for 2013 in my Sluggish Business Conditions Expected to Continue post. Now the Washburn University Applied Portfolio Management students have completed their own update to my forecast, which is posted below. The goal of the exercise is to identify the stage of the US business cycle and map that to the corresponding stage of the financial cycle (which leads the business cycle, as shown in the diagram below):
The analysis is used to practice "sector rotation," i.e., put new money to work in the stock sectors thought to perform well at that particular stage of the financial cycle, and allocate away from sectors that are positioned to do poorly.
The APM students' notes and rankings for The the Conference Board's 21 leading, coincident and lagging indicators are provided below. The closest matching variables from the FRED database (research.stlouisfed.org) are analyzed, in some cases replacing proprietary Conference Board metrics, such as consumer confidence and their leading credit index(TM). The students' overall interpretation of economic conditions is depicted in the table and graph below:
The diffusion index values and graph reflect the students' interpretations of the lagging, coincident and leading indicators (reviewed in detail below). Their analysis concludes that US business activity accelerated in early- to mid-2012 (lagging indicators = +87%), and accelerated even further through Q4 and the end of the year (coincident indicators = +93%). Looking forward, however (leading indicators = -12%), their call is that the pace of business activity will cool off slightly, which is in line with the recent surprising contraction for US GDP (-0.1% for Q4 2012). With the pace of economic activity slowing, the students' overall conclusion is that the economy is entering a contractionary phase -- whether it's a mid-cycle slowdown or beginning of a recession remains to be determined -- which means we are just past the peak of the financial cycle, as evidenced by the recent outperformance of "risk-on" sectors such as financials and industrials:
Leading Indicators. The students' ratings for each of the leading indicators, along with the Conference Board weights for each indicator, are shown in the table below, with detailed notes following:
Average Length of the Manufacturing Workweek:
The most highly weighted leading indicator, Average Length of the Manufacturing Workweek, measures the average number of hours worked in a week for US manufacturing employees. Emerging from the 2008 recession, the metric successfully led the market uptrend beginning in May of 2009, shortly before the recession had officially ended. Since that time, the measure has stabilized to its pre-2008 recession levels. It is interesting to note that, although the number of hours in a workweek remains stable, total manufacturing employment has been in a dramatic downtrend that started before the 2008 recession. Overall, it appears that the Average Length Manufacturing Workweek indicator has established a “new normal”, evidenced by stability in the number of hours worked, but a significant decrease in total manufacturing employment. The indicator is rated zero.
ISM New Manufacturing Orders Index:
The ISM New Manufacturing Orders Index is a diffusion index that measures the number of manufacturing orders received by US manufacturers. The index has been highly volatile over the past 20 years, which has hampered its ability to effectively act as a leading indicator. Immediately after the close of the most recent recession, the metric returned to levels sustained prior to the downturn in the economy, but has been balancing itself around the 50 mark throughout the last 18 months. It should be noted the short-term trend in the diffusion index is beginning to mirror the trends prior to the 2001 and 2008 US recessions. Given its sustained trend of volatility, the ISM New Manufacturing Orders Index is expected to continue fluctuating around the 50 mark, which could signal the beginning of a new economic recession if there is any further decline in the index. This indicator merits a -1.
Consumer Sentiment Index:
Reflecting the changes in consumer preferences within the economy, the Consumer Sentiment Index is one of the few economic indicators that is expectations-based. Just prior to the 2008 recession, the index had some marked volatility, but was more stable until around 2007, when a sharp decrease signaled an economic recession. Notice in late 2012 the index dropped sharply, indicating that consumer confidence in the US economy has still been fairly negative since the end of the most recent recession. Despite a relatively upward trend in the Consumer Sentiment Index, the growth has been much slower than in prior years. Overall, the Consumer Sentiment Index is expected to remain stable or begin a downward trend, as consumer confidence in the economy remains at a low point since the commencement of the 2008 recession. This indicator warrants a score of zero.
Interest Rate Spread, 10-year T-Note Yield Less Fed Funds Rate:
The interest rate spread, also known as the yield curve, measures the difference between 10-year Treasury bond rates and the overnight federal fund rates. The slope of the yield curve is primarily influenced by the Federal Reserve Board’s monetary policy and investor expectations of long-term interest rates. In previous business cycles, the interest rate spread has been relatively effective in signaling economic changes; however, in 2008, the metric appeared to lead the recession too early on. Since the close of the recession, the spread has been trending downward, but has remained stable at 1.5%. Overall, given that interest rates are expected to remain low, the interest rate spread is expected to either remain stable or slightly decline over the next 6-9 months, which would send a negative signal regarding future economic growth. This indicator is scored zero.
Manufacturers' New Orders for Consumer Goods:
Measuring the amount of new durable goods ordered by consumers, the nominal and real durable goods orders chart tracks the money spent on items with larger price tags and longer lives. While the chart dropped off severely prior to the 2001 recession, it seemed to take longer to adjust and drop in 2008. Notice that the peak in 2011 for durable goods orders was far below the previous peaks in 2007 and 2000, indicating that while some consumers are ready to purchase items for the long run, others are still wary of economic conditions. After the 2008 recession, orders increased quickly until 2012; from 2012 to the present, there has been a steady decline, which could predict further contraction of durable goods ordered. As the 2011 peak’s downslope is not nearly as sharp as the peak in 2000, one could assume that the market is simply adjusting and the downward movement seen recently will be offset by some upward movement. Therefore, this indicator merits a zero rating.
Chicago Federal Reserve National Financial Conditions Index:
The Chicago Federal Reserve Board (FRB) diffusion index measures how easy or tight credit conditions are in the US. As the value trends downward past zero, the ability for an individual to borrow money in the US becomes easier, characterized by loosened credit restrictions. Just prior to the most recent recession, this indicator peaked just as the recessions was considered to have begun, unsuccessfully indicating a downturn in the economy. The Chicago FRB diffusion index fell approximately 300bps to a low of -1.5% just after 2010 and has slowly recovered. Given the Federal Reserve’s current policy, characterized by ongoing low interest rates since the end of the 2008 recession, the index has been only increasing slightly. Consequently, the Federal Reserve Bank is expected to keep interest rates very low over the 6-9 months, which concludes that the Chicago FRB diffusion index will continue on its slow trend upwards, but will remain below zero, indicating continued loose credit conditions. This indicator will be rated +1.
S&P 500 Stock Prices:
Since stock prices are thought to be forward-looking discounting mechanisms, it is easy to conclude that stock prices should lead the economy. While both the 1991 and 2001 recessions were successfully predicted by this indicator, the recovery in 2002 actually lagged behind until 2003. Notice that we have been in a secular bear market for the last 12 years after stock prices are adjusted for inflation. This means that, while the real stock prices do have a recovery period during the expansion, the peaks have fallen progressively lower in the expansions following the 2001 and 2008 recessions. The most important thing to realize is that right now, the stock market is trending up; though it may not be an explosion of upward momentum, it has been rising since mid-2012 and has not taken a downturn yet. Given the slow trend in the real S&P 500, this indicator merits a score of zero.
New Orders for Non-Defense Capital Goods:
The Capital Goods Orders graph shows spending on capital goods by US businesses. Though the series predicted an economic downturn in 2008, the capital goods orders almost missed the 2008 recession entirely; it was lagging at the beginning of the recession and barely had an upturn before the recession ended. Notice that, although the real line peaks in both 2008 and 2011, these peaks are not even close to the previous high point realized in 2001. The graph shows that capital investments have been contracting for the whole year of 2012 and capital investments have been generally shrinking since 2000. Overall, as we just had a peak in 2011 and these peaks are followed by troughs, further contraction of capital investment can be expected. Consequently, this indicator will be rated -1.
Average Weekly Unemployment Claims:
The Average Weekly Initial Unemployment Claims leading indicator measures the number of people filing for new unemployment benefits. The indicator has an anti-cyclical relationship with the business cycle; a low number of unemployment claims indicates the economy is expanding. In recent years, it has been a relevant indicator in illustrating the economy‘s downward spiral during the 2008 economic recession. Prior to the past 2001 and 2008 recessions, weekly unemployment claims remained low until sharply increasing in the months leading up to the economic recessions. As seen in the graph above, the amount of claims has dropped tremendously since its peak in 2009. Notice how the metric is currently balancing around 375,000 per week, which appears to be relatively high compared to the 1990s. Although comparatively high, recent months show a slight downward trend of average weekly unemployment claims, indicating the economy is slowly recovering from the 2008 recession. The indicator will be given a rating of zero.
New Building Permits:
This indicator measures the number of new private housing construction permits requested by home builders. Prior to the 2008 recession, the number of building permits gradually declined, successfully indicating a recession was about to surface. It is also interesting to note that during the last recession in 2008-2009 the number of new housing building permits reached a 30-year low. Reviewing the metric’s trend over the past few years, steady growth in the number of permits authorized represents a strengthening economy. Overall, the number of building permits for new private housing has yet to surpass pre-recession levels, but is expected to remain trending upward over the near-term. Therefore, this indicator will be rated at zero.
Coincident Indicators. The students' rankings for the Conference Board's four coincident indicators are shown in the table below; detailed notes on each indicator follow.
Manufacturing and Trade Sales:
The indicator of manufacturing and trade sales is a coincident indicator that measures the total retail sales and real total retail sales (accounting for inflation). This indicator acted as a leading indicator in piror business cycles, and as a coincident indicator in more recent years. Both total retail sales and real total retail sales have been on a steady rise since 1992. Total retail sales surpassed real total sales during the 2008-2009 recession. The steady uptrend indicates a growing economy. Retail sales have resumed normal rate of growth since the 2008-2009 recession and are showing a full recovery. This indicator therefore merits a diffusion index score of +1.
Total Nonfarm Payrolls:
Total nonfarm payrolls is a coincident indicator that measures the total number of people in the US with a fulltime/part time job, temporarily or permanent. The total number of nonfarm payrolls has decreased during the recession (2008-2010) but increased since 2010. Total nonfarm payrolls is getting back to the level that it achieved before the recession. The overall trend is going upward. The upward trend and steady increase of the total nonfarm payrolls is indicating a recovering market and economic expansion. For this reason the coincident indicator nonfarm payrolls gets a diffusion index of +1.
Personal Income Less Transfer Payments:
Personal income less transfer payments is a coincident indicator measuring the extent to which income in the US is growing from market base sources excluding any government redistribution of income. US GDP grows by a greater amount when consumers’ spend freely. Personal income is the main source of spending. Transfer payments are redistributions of tax revenues by the government including social security, welfare and business subsidies. The indicator lagged true economic conditions by several months, for instance during the last recession (2008-2010), when it reflected the overall economic situation two months late. Nevertheless, personal income less transfer payments is at an all-time high and increasing. Therefore personal income less transfer payments will receive a diffusion indicator score of +1.
The index of Industrial production is a coincident indicator which measures physical output at all stages of production in the manufacturing, mining, gas and electric industries. Although the industrial sector only represents a fraction of the total economy, this index is positively correlated with changes in total output. The nominal works well as a coincident indicator, increasing and decreasing in sync with economic expansions and contractions. The inflation adjusted industrial production index fails to increase during the 2002-2007 expansion, although it decreases sharply with the 2008-2009 recession and rebounds weakly before resuming a sideways trend. Although both series have been increasing slightly since the last recession, the series did not manage to grow over the past 12 years, which is not indicating current economic expansion. Therefore this indicator will receive a diffusion index of zero.
Lagging Indicators. The students' rankings for the Conference Board's seven lagging indicators are shown in the table below; detailed notes follow.
Average Prime Rate:
The Average Prime Rate is a benchmark used for pricing loans. The indicator trails the economy as banks set the price of credit. The demand for credit will grow if the economy has been expanding, and banks can mark up the price of credit and charge higher rates. Commercial and Industrial Loans depicts the level of the interest rate regardless of total loans outstanding. If new credit is not created due to low rates, the economy may not expand. The Average Prime Rate functions more like a leading indicator heading into recessions as the US Federal Reserve begins cutting interest rates in anticipation of future economic weakness. During the last three recessions, it acted as a lagging indicator, increasing well after the end of the previous recessions. The Average Prime Rate has been in a secular downtrend for the past thirty years, declining with the general decrease in inflation and interest rates for the same period. The Prime Rate has remained very low rate due to the Fed’s commitment to zero interest rate policy ever since the 2008-2009 recession. Low interest rates have contributed to the rebound of commercial and industrial loans. The Prime Rate could not be much lower, and business loans are increasing, therefore this indicator is scored +1.
Ratio of Consumer Credit to Personal Income:
Consumer Credit to Personal Income functions as a lagging indicator. Consumers normally wait to increase borrowing for at least 3 to 6 months after a recession ends and they can see tangible signs of economic recovery. Consumer credit to personal income functions well as a lagging indicator around 1981-1982 and 1991-1992 recessions. During the early 2000s credit bubble, the current value of the series becomes hard to discern. Early in the 2008-2009 recession, the ratio began a sharp decrease, which means consumers offset the lost income during the latter part of recession by increasing borrowing relative to income. As teh recovery began, the ratio declined as income grew and consumers reduced debt. In the recent two years, the ratio began to climb back close to its last high point, which may suggest that total personal income has grown to the point that consumers feel comfortable increasing their total borrowing once again. The series decreases by 1% after each recession, which means consumers still have old debts to pay off before a new cycle of consumer borrowing begins. In the long term, the main trend of this series is upward. Therefore the indicator will be rated as a +1.
Consumer Price Index for Services:
The Consumer Price Index for Services is a lagging indicator that measures the percentage increase or decrease in the cost of services over time. The index only sometimes (1983 and 2009) lags behind the economy, other times (1988 and 1998) it reflects increase in service costs before a recession. Notice how the index increased sharply (4.4%) following the 2008-2009 recession, but has decreased by a greater percentage (7%) since. The index is decreasing on the whole, indicating a decline in the cost of services over time. Note that the index has not reliably lagged behind economic changes. Nonetheless, the comprehensive decrease in cost of services suggests recovery from the most recent recession. This index receives a +1.
Commercial and Industrial Loans:
The index of commercial and industrial loans is a lagging indicator that measures the amount of consumer and commercial borrowing. Troughs in borrowing usually occur a year or more after a recession ends. Consumer borrowing has risen at a faster pace than commercial borrowing. After recessions, commercial borrowing decreases more than consumer borrowing. After the 2001 recession consumer borrowing did not slow down at all. Both consumer and commercial borrowing have reached or exceeded their pre-recession levels indicating the economy has recovered. In the past, borrowing has steadily increased, with the exception of post-recession periods. Currently borrowing is increasing again indicating economic growth. This indicator therefore merits a diffusion index score of +1.
Inventory to Sales Ratio:
The Inventory to Sales Ratio Index is a lagging indicator that measures the amount of inventory held as a percentage of sales. The index reliably decreases by a larger percentage than normal after a recession. Notice how the index increases significantly before or during a recession and decreases at the end of a recession. The index has remained relatively unchanged (between 1.25 – 1.30) since 2010 indicating an Inventory to Sales Ratio similar to pre-recession conditions. Significant increase in Inventory to Sales hasn’t consistently lagged behind economic recessions. However, significant decreases in Inventory to Sales Ratio have reliably indicated the onset of and expansion phase. Therefore, this index receives a +1.
Unit Labor Costs:
The index of unit labor costs is a lagging indicator that measures amount of labor cost per worker and the real amount of labor cost per worker (which considers inflationary effects). Labor cost per worker usually peaks midway through a recession and decreases about a year after a recession. Notice how unit labor costs are increasing while real unit labor costs are decreasing. Unit labor cost increasing indicates U.S. businesses are adapting to higher wage demands from workers. Real unit labor cost indicates the unit labor cost increase has increased slower than the rate of inflation, however. An increase in unit labor cost since the last recession shows economic growth. The continual decrease of real unit labor cost indicates workers' wages are not keeping up with inflation. Therefore this indicator receives a score of zero.
Duration of Unemployment:
The indicator of average duration of unemployment is a lagging indicator that measures the average weeks a person is unemployed. The labor force participation rate is also depicted. Duration of unemployment has increased during recessions and continued to increase for about a year after recessions before slowly declining. The labor force participation rate has steadily been decreasing and not shown any sign of turning around since the 2001 recession. Notice that duration of unemployment hit an all-time high after the 2008 recession and has only recovered about one-fourth to the level it was before the recession. Also, the labor force participation is at an all-time low. Unemployment and labor force participation have not recovered since the 2008 recession. The average duration of unemployment indicates little or no economic expansion. This indicator therefore merits a diffusion index score of -1.
Macro-Finance Outlook February 2012
(Conference Board Weights are shown after each indicator)
Lagging Economic Indicators
Average Bank Prime Rate (28.1%). This indicator moves counter cyclically with the economy. The graph shows that a trough occurred in 2011 and borrowing is increasing. This means that expansion has occurred but it is negated by the fact that the prime rate has stayed low. Conclusion: The demand for new credit has not grown enough to support an increase in the prime rate. (-1)
Consumer Price Index for Services (19.1%). The time series shows an increase in volatility during recessions. Since 2009 the mean is stationary and there are few changes. Conclusion: the indicator currently has no correlation to the current state of the economy. (0)
Ratio of Consumer Credit to Personal Income (18.9%). Consumers will wait roughly a year after a recession ends to start borrowing again. A trough occurred in 2011 and consumer installment credit/personal income has since started to increase along with personal income. Conclusion: The upswing in both of these variables signal that the economy has been growing. (+1)
Inventory to Sales Ratio, Manufacturing and Trade (12.6%). When times are good companies are able to move their inventory more rapidly and consistently. This indicator peaks midway during recessions, and has declined during the 2011 expansion. Conclusion: this is a strong economic indicator that is showing signs of expansion. (+1)
Commercial and Industrial Loans (11.1%). The two time series show peaks during recessions. The trend since 2011 is positive with a steep slope. Conclusion: We have seen economic expansion the last few years and should continue to see increase in business borrowing as the economic expansion continues. (+1)
Unit Labor Cost, Manufacturing (6.2%). Real unit labor costs are rising while the nominal until labor costs are declining. Declining costs are good for business but declining wages are bad for the workers. Conclusion: This indicator is conflicting for the economy. (0)
Median Duration of Unemployment (3.7%). The indicator has reached a much higher level after the 2009 recession that what would be ideal for a recovering economy. The median would be expected to decrease after the recession and has failed to show a significant negative trend. Conclusion: The slow growing economy is not recovering fast enough to replenish the jobs lost during the last recession. (-1)
The summary table of Lagging Indicators is shown below. The unweighted score of 14% and the weighted score of 11% indicate that the US economy grew at a slow pace during Q3-Q4 2011.
Coincident Economic Indicators
Employees on Nonagricultural Payrolls (54.1%). This indicator hit a low in 2010 and has started to rebound since. The rise in employment is a sign that the economy is growing. Conclusion: The rate in which it is growing is not fast enough to merit more than a neutral mark. (0)
Real Personal Income Less Real Transfer Payments (19.1%). This indicator has rebounded to the same level as in pre-recession. However, the time series levels off during the 2011 expansion instead of following the uptrend. Conclusion: the indicator is not rising or falling, therefore it is not a good reflection of the current economy. (0)
Personal Income, Personal Consumption, and Transfer Payments (supplemental). This indicator has rebounded to the same level as in pre-recession. However, the time series levels off during the 2011 expansion instead of following the uptrend. Conclusion: the indicator is not rising or falling, therefore it is not a good reflection of the current economy. (0)
Industrial Production (14.9%). The time series is a very troubling picture of the United States. With decreasing production overall since the 70’s, it is evident that production on our shores will not increase with the economy. Conclusion: the overall trend continues to be a downward slope. More recent data appears to be more white noise than a real significant increase. (-1)
Real Manufacturing and Trade Sales (11.9%). When trade sales and real manufacturing increase the economy grows. This graph shows that both are on the rise. Conclusion: This signals a growing economy. (+1)
The scores of the four Coincident Indicators are shown below. The unweighted score of 0% and the weighted score of -3% indicate that the pace of economic expansion in the US is likely to remain slow for Q1-Q2 2012.
Leading Economic Indicators
Real M2 Money Supply (35.5%). Real M2 has grown steadily since the mid-nineties, while the velocity of M2 displays a long-term decline. Increases in M2 have failed to significantly stimulate consumer and business loans since the recession. Conclusion: Increases in the money supply have been ineffective in generating significant growth. Score: 0.
Real M2 Money Supply and the Velocity of Money (supplemental).
Average Length of the Manufacturing Workweek (25.5%). The Average Length of the Manufacturing and Construction Workweeks formed a trough during the recession in 2009. The average workweek normalized in 2010. Employment in manufacturing and construction has not grown since the recession, however. Conclusion: The current stability of this indicator came at the expense of over 5,000 jobs. Score: 0.
Total Employment in Manufacturing and Construction (supplemental).
Interest Rate Spread, 10-Year Yield Minus Fed Funds (10.2%). The Interest Rate Spread dropped below zero in 2007 and 2008, while investors feared a recession. Rates are falling due to investors reallocating from stocks to bonds in 2011, flattening the yield curve. Conclusion: The Interest Rate Spread indicates that investors are less optimistic about the economy. Score: -1.
The Yield Curve (supplemental).
Manufacturers' New Orders, Consumer Goods and Materials (7.7%). Manufacturers’ New Orders for Consumer Goods plummeted during the recession in 2008 and 2009. New orders increased throughout 2010 and 2011. Conclusion: Despite the low level of new orders, this indicator displays a strong positive trend. Score: +1.
Suppliers Delivery Index (6.7%). The suppliers delivery index was on a steady decline throughout 2011, indicating that business activity is slowing. Conclusion: This indicator receives a score of -1.
Stock Prices, S&P 500 (3.9%). The United States stock market has been in a secular bear market for the past 11 years. The nominal value of the stock market has nearly rebounded from the 2009 recession. The real value of the index displays a long-term decline, however. Conclusion: The S&P 500 Index illustrates a volatile stock market. Score: -1
Average Weekly Claims for Unemployment Insurance (3.1%). Claims for unemployment insurance peaked at the end of the recession in 2009. Though unemployment insurance claims remain high, claims continued to decline at a formidable rate. Conclusion: The steep downward slope in unemployment insurance claims warrants a score of +1.
Index of Consumer Expectations (2.8%). Consumer expectations suffered at the hands of the recession in 2008 and 2009. Conclusion: Consumer expectations did not rebound significantly from the recession and appear to be leveling out. Score: 0.
Building Permits, New Private Housing Units (2.7%). Building permits for new private housing units rapidly decreased from 2006 to 2009. Building permits remain at an all-time low. Conclusion: Building permits have failed to recover from the recession, scoring this indicator a -1.
Manufacturers' New Orders, Nondefense Capital Goods (1.9%). Manufacturers’ new orders made a strong rebound in 2010 following the recession. Growth in new orders slowed in 2011, however. Additionally, manufacturers’ new orders adjusted for inflation reflect a long-term declining trend. Conclusion: The recent growth in new orders is not strong enough to break out of the long-term decline, warranting this indicator a score of 0.
All 10 Leading Indicators are shown in the table below. A leading indicator score of -20% suggests that economic growth will slow in early 2012. Increased demand for consumer goods and declining unemployment will generate mild growth. Investors remain fearful, however, evidenced by the decreasing interest rate spread, the volatile stock market, and a depressed housing market. Poor fiscal policy, domestic political instability, and fears of European default contribute to the secular bear market.
A visual depiction of the Lagging, Coincident and Leading indicators appears in the graph below. The graph depicts the stagnation of the US economy predicted by the above analysis.
Percent Job Losses in Post WW2 Recessions. The recent recession of 2007 caused the largest percent job loss since 1948. At the current rate of job recovery, the American economy will take over five years to regain lost jobs. High unemployment infers lower consumer demand. Conclusion: Economic growth will be stifled by high unemployment.
Case-Shiller Price Cumulative Declines from Peak (SA), Year and City. The most valuable asset for many Americans, their home, declined significantly over the past five years in the nation’s largest cities. Negative equity prevents homeowners from relocating, contributing to structural unemployment. Foreclosures continue to weigh on a struggling financial sector. Conclusion: The housing crisis continues to have a negative impact on the economy.
Ratio of US Debt to GDP. Since the recession of 2007, the Debt/GDP has grown approximately 35% to a ratio of nearly 1. Economies with Debt/GDP ratios over 1 usually grow at half the rate of economies with Debt/GDP less than 1. Conclusion: The large amount of American debt will slow economic expansion.
Core CPI and PPI. The change in Core CPI and PPI increased approximately 3% over the past year, decreasing the purchasing power of the American consumer. Conclusion: High inflation will suppress economic growth.
Macro-Finance Outlook December 2011
This article analyzes the indicators comprising the Conference Board's Lagging, Coincident and Leading Economic Indexes. Each indicator is analyzed individually, scored -1, 0, or +1 for mostly negative, neutral, or mostly positive, and then averaged into Lagging, Coincident and Leading diffusion indexes scaled from -100% (economic free fall) to +100% (robust expansion).
Here's the upshot of the article: The first graph below depicts the equally-weighted diffusion indexes. The Lagging indicator score of +14% corroborates that the US economy was experiencing painfully slow growth during most of 2011. The Coincident indicator score of +25% suggests improving business conditions and accelerating growth late in 2011. The Leading indicator score of -10% suggests that the recent improvement in business conditions will not accelerate further, and the slow-growth environment will persist through the first half of 2012, at least.
If the indexes are calculated using the Conference Board's weights, the results are similar, as shown in the graph below. The Lagging, Coincident and Leading scores equal +11%, +16%, and -11%, respectively.
Conclusion: The Conference Board's Economic Indicators confirm that the US economy grew slowly in 2011. Conditions for growth improved slightly in the 4th quarter. Growth is not expected to accelerate for the first half of 2012, however, and may slow further. The US economy remains vulnerable to the forces that may have already tipped Europe into a recession.
Lagging Economic Indicators
Average Bank Prime Rate (28.1%). Real Total Business Loans are also depicted (red line). A rising average prime rate indicates increasing demand for credit, as banks mark up the price of interest. Thus far the prime rate has failed to turn upwards in sync with business borrowing as it did in 2004. Score this indicator -1, as it fails to corroborate the 2011 economic expansion.
Consumer Price Index for Services (19.1%). This indicator peaks midway during a recession. It has displayed no meaningful trend since 2009. Score this indicator zero for neutral.
Ratio of Consumer Credit to Personal Income (18.9%). Real Personal Income is also depicted (red line). Consumer Credit/Personal Income is expected to display a trough several months after Real Personal Income begins rising, which is exactly what the indicator shows for late 2011. Score this indicator +1.
Inventory to Sales Ratio, Manufacturing and Trade (12.6%). This indicator rises during recessions as inventories accumulate, and declines during expansions. The indicator trended downwards in 2011, thus earning a score of +1.
Commercial and Industrial Loans (11.1%). Both the nominal and real series are displayed. Both series display a significant uptrend, confirming economic expansion as they did in 2004-2005. Score this indicator +1.
Unit Labor Cost, Manufacturing (6.2%). Both the nominal and real series are displayed. Unit Labor Costs are expected to peak midway through a recession, which occurred in 2009. But Real Unit Labor Costs have been in a downtrend for 15 years, which may be good for business, but bad for the working class. Score this indicator zero for a mixed or neutral reading.
Median Duration of Unemployment (3.7%). The Labor Force Participation Rate is also shown. Unemployment Duration is expected to gradually decline as an expansion picks up steam. All official unemployment series get an unnatural boost from not counting the underemployed and discouraged labor force dropouts, however. The staggeringly high median duration of 22 weeks merits a score of -1. It is worth noting that the series took a long time to begin trending downward following the last recession, however, so improvements in this series may be forthcoming.
The summary table of Lagging Indicators is shown below. The equally-weighted and Conference Board-weighted scores of +14% and +11% confirm that the US economy experienced growth in 2011, but this growth was painfully slow.
Employees on Nonagricultural Payrolls (54.1%). Total Nonfarm Payrolls (blue) and Total Nonfarm Hiring (red) are shown below. While both series have indeed turned upward, the US employs the same number of workers as it did in 2001, and is adding new workers at an almost ridiculously slow pace. Score this indicator zero for neutral, as the positive percentage changes are offset by the low level of the series.
Personal Income Less Transfer Payments (19.1%). Real Personal Income Less Real Transfer Payments is shown below. (A more granular view appears in the 2nd graph.) The series has bottomed, but the trend is flat, rather than rising.
Personal Income, Personal Consumption, and Transfer Payments (green) are depicted below. Total Transfer Payments fueled much of the rise in Personal Income over the past 2 years. With Transfer Payments leveling off (and predicted to decline in 2012), growth in Real Personal Income will most likely stagnate for a while. This indicator is right on the border, but the trend is up so I will score it +1.
Industrial Production (14.9%). The Nominal and Real series are shown. Nominal Industrial Production displays a promising rebound, but when adjusted for inflation, the long-term downtrend in the series is more evident. Score this series -1, as it bespeaks an economy in a long-term decline.
Real Manufacturing and Trade Sales (11.9%). Total Household Debt is also shown (as much of the sales growth from the past decade was fueled by debt). The series shows a smart rebound, and merits a score of +1.
The scores of the four Coincident Indicators are shown below. The diffusion scores are 25% (equally-weighted) and 16% (Conference Board weights), respectively, slightly higher than the Lagging Indicator scores. This suggests modest improvements in business conditions and economic growth in late 2011.
Real M2 Money Supply (35.5%). Real M2 is depicted below, along with Real Consumer and Business Loans. The 2nd graph charts Real M2 with the Velocity of M2.
The Real M2 Leading Indicator reveals some of the weaknesses in the Conference Board system, which scores series based on their percentage changes. Real M2 is definitely rising, but not due to market forces (strong demand for credit or liquidity) -- it's mainly driven by Federal Reserve intervention (manipulation?). Neither total borrowing nor velocity (shown below) is rising. Score this indicator zero -- M2 is rising, but the damage from the Fed's loose money policies will most likely plague us for a generation (see the inflation statistics below).
Average Length of the Manufacturing Workweek (25.5%). The average length of the Construction Workweek is also depicted. This is another Conference Board indicator that looks good on the surface, as the Manufacturing Workweek has rebounded to its pre-recession levels.
With a bit more context, the apparently positive signal looks somewhat different, however. Consider Total Employment in Manufacturing and Construction, depicted in the graph below. The length of the respective workweeks was restored at the cost of permanently eliminating 5 million high-paying middle- and working-class jobs. Score this indicator zero, as the rising workweek is offset by signs of a dramatically contracting labor market.
Interest Rate Spread, 10-Year Yield Minus Fed Funds (10.2%). The yield on the 10-year T-note minus the Fed Funds rate is really a proxy for the slope of the yield curve, depicted in the 2nd graph below.
The Yield Curve flattened considerably in 2011. A flattening Yield Curve suggests economic slowdown, so score this indicator -1.
Manufacturers' New Orders, Consumer Goods and Materials (7.7%). Real Durable Goods is depicted along with Consumer Sentiment (the strong positive correlation is evident). This is a tough one to score -- Real New Orders are rising following the last recession, but the inflation-adjusted series achieves lower highs following each of the last two recessions. I had to inject a bit of subjective optimism to score this indicator +1.
Suppliers Delivery Index (6.7%). This index is trending downward for most of 2011, thus meriting a score of -1.
Stock Prices, S&P 500 (3.9%). The Real and Nominal S&P 500 is shown below. The long-term market trend looks flat in nominal terms, but registers as a secular bear market in real terms.
If you're still not convinced, consider the S&P 500 Total Return since 2001 deflated by the value of the US Dollar. The dramatic loss of purchasing power for buy-and-hold investors is clearly evident. This series earns a score of -1. The secular bear market in stocks continues.
Average Weekly Claims for Unemployment Insurance (3.1%). Unemployment is deliberately measured with a positive bias, as workers too discouraged to keep looking are no longer counted. Nonetheless, the series is trending downward, and merits a score of +1.
Index of Consumer Expectations (2.8%). This series displays a sideways trend around a scarily low level, which justifies no more than a score of zero.
Building Permits, New Private Housing Units (2.7%). This series looks like the backdrop graph in a Dilbert comic strip. Too bad the process doesn't allow me to score it less than -1.
Manufacturers' New Orders, Nondefense Capital Goods (1.9%). Real Nondefense Capital Goods orders are shown below. The series is rising strongly, so I will score it +1, but this was a close call, as the long-term trend suggests inexorable slowdown.
All 10 Leading Indicators are shown in the table below. The scores of -10% and -11% suggest that the economy will find it difficult to extend the meager progress seen in late 2011.
Conclusion: The Lagging indicator score of +14% corroborates that the US economy was experiencing painfully slow growth during most of 2011. The Coincident indicator score of +25% suggests improving business conditions and accelerating growth late in 2011. The Leading indicator score of -10% suggests that the recent improvement in business conditions will not accelerate further, and the slow-growth environment will persist through the first half of 2012, at least.
Supplementary Economic Indicators
Ratio of Corporate Profits to GDP. I find it fascinating that the "normal" ratio of Corporate Profits to GDP seems to have doubled during the lost decade in stocks. The "corporatization" of the US has not been good for Main Street.
Ratio of US Debt to GDP. By now, everyone is familiar with the Rogoff and Reinhart (2009) study showing that advanced economies with Debt/GDP ratios greater than 100% grow half as fast. The US is just about there, and borrowing more every time Congress is in session. The trend in total Federal Government Debt is asymptotic, and clearly unsustainable.
U6 Unemployment + Underemployment. The spread between the unemployed and underemployed expanded rapidly early in the current economic recovery. The manner in which unemployment is measured is outdated, and intended to impart a deliberate positive bias to the unemployment numbers.
Case-Shiller Home Price Index. Yet another sharp downturn for the Case-Shiller Index. Markets experiencing extreme real estate bubbles, such as Las Vegas and Phoenix, continue plunging.
Core CPI and PPI. The bean-counters that calculate inflation have done everything in their power to report misleadingly low inflation statistics, but they seem to be running out of tricks. Core CPI and PPI continue spiking to 1980s-type levels.
Real Oil and Gas Prices. Oil and Gas prices have been rising faster than the Energy CPI for decades. This functions as a tax on the US Consumer (collected by large, integrated energy companies). From 2009 through early 2011, commodities prices soared at every sign of global economic strength, which neutralizes economic growth in consumer- and automobile-oriented economies like the US.
Macro-Finance Outlook March 2011
This analysis will begin with an examination of the Conference Board’s leading, coincident and lagging indicators to determine the stage of the current business cycle (e.g., early expansion vs. late expansion). The analysis concludes by considering additional indicators that further reflect the health and vitality of the economy.
The M2 Money Supply (weighted 0.355, in blue below), has been increasing aggressively as a result of the Federal Reserve’s pro-liquidity programs (TARP, Quantitative Easing, etc.). Although rapid growth in the money supply is normally associated with economic growth, thus far all the loose money in the economy has not found its way into new consumer or business borrowing (red and green lines). The extent to which M2 growth is having a positive impact on the economy therefore remains questionable.
The Average Length of the Manufacturing Workweek (weight = 0.255, in blue) began increasing late in the last recession, and has since leveled off. Total employment in manufacturing (in red) has not increased, however -- millions more manufacturing jobs were lost in the last recession.
The Interest Rate Spread, measured as the 10-year Treasury Yield minus the Fed Funds rate, (weight = 0.102), shows that the Treasury Yield Curve now has a steep upward slope, further suggesting continued economic expansion. As mentioned above, however, while a steep yield curve means that banks have a strong incentive to lend, there is little evidence that credit creation is expanding.
The Suppliers’ Delivery Index (weight = 0.067) declines during recessions and then gradually increases until late in the ensuing expansion. Although volatile, this indicator is currently trending upward, suggesting continued expansion of the economy.
S&P 500 Stock Prices (weight = 0.039) have now officially doubled from their low in March 2009. The strong bull market in stocks forecasts continued economic expansion.
Initial Unemployment Claims (weight = 0.031) tend to peak at the end of each recession, then decline as the economy begins to recover. The trend in initial claims indicates that fewer people are losing their jobs, but the current lows are equal to the peak in 2003, suggesting that the pace of layoffs remains elevated. Without robust job creation, the sustainability of the economic expansion remains questionable.
The University of Michigan Index of Consumer Sentiment (weight = 0.028) consistently increases prior to the end of recessions. Consumer sentiment has recovered from its lows in the recent recession, but remains suppressed compared to previous expansions. Sentiment has not been this low since the economy emerged from the 1970s-1980s double-dip recessions.
New Building Permits for Private Housing (weight = 0.027). Following the collapse of the housing market, this indicator is currently at an all-time low and shows no signs of recovery, suggesting painfully slow growth for the housing industry. This would be the first economic expansion in over half a century where the housing market did not participate.
New Orders for Nondefense Capital Goods (weight = 0.018) bottomed out just before the end of the recession, which is typical behavior for this indicator. The strong uptrend in new orders forecasts continued economic expansion, although this indicator did take a large, unexpected dip in January 2011, so it bears further watching.
Total Nonfarm Payrolls (weight = 0.543, in blue), although classified by the Conference Board as a coincident indicator, has behaved more like a lagging indicator in the past two recessions. Nonfarm Payrolls have expanded slightly from their low in early 2010, but the trend is insufficient to regain the millions of jobs lost during the Great Recession. Also shown is Total Nonfarm Hiring (in red).
Personal Income Less Transfer Payments (weight = 0.189) has regained its pre-recession level, but over the last 30 years, Wage and Salary Disbursements (in red) have lagged. The widening gap between the two series indicates the increasing gains in income for individuals who receive a substantial portion of their income from their investments, rather than wages and salaries.
Industrial Production (weight = 0.149) has been a reliable indicator, turning upward at the end of the past 5 recessions. The current uptrend suggests the economy is well into its expansionary phase.
The Bank Prime Rate (weight = 0.282, in blue) and Total Loans and Leases at Commercial Banks (weight = 0.111, in red). The average Bank Prime Rate is lower than it has been in 30 years, suggesting that credit conditions are favorable for growth. Total Loans and Leases at Commercial Banks continue declining, however, albeit at a much slower pace.
The CPI for Services (weight = 0.196) has been of questionable value as an indicator in both of the last recessions. The series currently displays no meaningful trend.
Ratio of Consumer Credit to Personal Income (weight = 0.188) continues plunging, reflecting consumer deleveraging. Also shown is Real Disposable Income (in red). The moderate increase in income suggests that the decline in the Credit-to-Income ratio is mainly driven by a decrease in consumer credit.
The Inventory-to-Sales Ratio (weight = 0.124) is another indicator whose value is questionable, as the ratio has been in a 30-year downtrend due to just-in-time inventory management practices. Inventories are nonetheless low relative to sales, indicating that there is little chance the economy will stall due to an overhang of unsold inventories, so the indicator is generally positive.
Unit Labor Costs (weight = 0.062) have leveled off, but as yet show no sign of increasing. Normally this would suggest that the economic recovery is in an early stage. Currently, this indicator is unlikely to show much of an increase until very late in the expansion, given the large number of unemployed and discouraged workers.
Median Duration of Unemployment (weight = 0.037, in blue). The median duration of unemployment is more than double its post-recession level from late 2002. As a lagging indicator, unemployment duration usually does not decrease until midway through an economic expansion, suggesting that we are in the early stages of the current expansion.
Macro-Finance Outlook: January 2011
Economic Outlook 2011 (Adobe Flash required). Professor Weigand reviews the current state of the economy, including the components of the Conference Board’s Leading, Coincident and Lagging indicators.